Don’t fall for the spin - Scott Morrison’s budget surplus is no certainty

Prime Minister Scott Morrison could yet be guilty of prematurely declaring that his government will deliver a budget surplus in 2018-19.

Sure, tax revenue is growing at a rapid pace and the government is underspending on a range of government services, but there are still seven long months to go between now and the end of the financial year that might yet blow up the surplus commitment.

PM Morrison’s ‘return to surplus’ boast is based, it appears, on hard data for the first four months of the 2018-19 financial year on revenue and spending information from the Department of Finance. These numbers do look strong, at least in terms of the budget numbers and if the trends on revenue and spending continue, the budget will probably be in surplus. Treasury will be factoring in ongoing economic growth, no increase in the unemployment rate and buoyant iron ore and coal prices over the remainder of the financial year. These forecasts and hence the budget bottom line are subject to a good deal of uncertainty, as they are every year.

If, as is distinctly possible, the economy stalls in the March and June quarters 2019, commodity prices continue to weaken and if there are some unexpected increases in government spending, the current erroneous forecasts for revenue and spending could leave the budget in deficit.

It is a dangerous game. Politically at least.

Economies and budgets can alter very quickly as a run of uncertain news and events impact on consumers and the business sector. Global shocks come jump out to derail even the best forecasts. Clearly, a lot can change for the budget between now and the Treasurer handing down of the budget on 2 April 2019 Budget.

Even more can change between when the budget is handed down and when the financial year comes to an end on 30 June 2019. This gap alone is a further three months of news that can have a material and unexpected impact on the budget bottom line.

Government spending in 2017-18 will be around $475 billion, a similar number to total revenue. A 1 per cent forecasting error on either revenue or spending could cost the budget close to $5 billion. And 1 per cent forecasting errors have occurred in the past. Mr Morrison’s proud announcement of a surplus seems risky, but it may be a political plus for the beleaguered government. Part of the electorate thinks that the budget balance is a measure of economic management competence and a surplus will be seen, by them, as good news.

But there is a twist.

The final budget outcome for 2018-19 – whether it is in surplus or deficit – will not be known until September 2019, some four months after the voters have made their decision. This means that in the event of a shock Coalition win at the election, the budget could ‘surprisingly’ drop back into deficit but, perhaps ironically, Mr Morrison will still be Prime Minister despite the failure to deliver on his promise.

At the macroeconomic level, there is very little difference between a budget deficit of a billion dollars or two and a surplus of a billion dollars or two. Recall annual GDP in Australia is close to $2 trillion.

But politically, the surplus / deficit issue can be important particularly when the surplus the government says it is delivering cannot be checked until after the election, even though it may sway a few voters to give their vote to the Coalition.

Word has it that the framing of the budget, due to be handed down by Treasurer Josh Frydenberg the day after April fools day (and around 6 weeks before the election), is more problematic than usual.

Problematic because there is some mixed news on the economy that will threaten the current forecast of a return to budget surplus in 2019-20.

Housing has gone into near free-fall, both in terms of prices and new dwelling approvals. This is bad news for GDP growth. The unexpected severity of the housing slump is the key point that will see Treasury revise its forecasts for GDP growth, inflation and wages lower when the budget is handed down.

It will be impossible for Treasury to ignore the recent run of hard data, including the weakness in consumer spending and a generally downbeat tone in the recent economic news when it sets the economic parameters that will underpin its estimates of tax revenue and government spending and therefore whether the budget is in surplus or deficit.

The prospect that interest rates will be lowered within the next few months is already starting to impact on the economy.

Here’s how.

Around the middle of 2018, financial markets were expecting the RBA to hike official interest rates to 1.75 or 2 per cent over the course of the next 18 months or so. If proof was needed that investors and economists can get it wrong, markets are now pricing in official interest rates to be cut towards 1 per cent over the next 18 months.

The about face has been driven by a raft of disappointing news on the economy, most notably the fall in house prices, the free-fall in new dwelling building approvals and a slump in retail spending growth.

Business confidence has also taken a hit and job advertisements have been falling for eight straight months. Ongoing low inflation and increasing signs of a slowdown in the global economy have simply added to the case for this dramatic change in market pricing.